Why Average Investors Get Shut Out of the Best Alternatives

GUS SAUTER: In the 1990s as alternative investments started to become more mainstream, investors were lured to the promise of higher returns that a number of high-profile institutional investors, such as large endowments and foundations, had received.

Investors did not realize that they were hearing about the returns of the best alts managers and that there was a wide distribution of returns between the most and least successful alts. This misconception was understandable because there was little transparency around returns and the poor-performing managers elected to not report their returns.

As the industry grew over the past decade and somewhat greater transparency has shed light on the mediocre performance of the average alt, the new sales pitch is that alts may not produce as high a return as broadly available traditional funds, but they provide returns with lower risk.

The reality is, just like mutual funds, the best performing alts perform quite well, but the majority leave you wanting more. The problem that most individual investors face is that they won’t have access to the best performers.

Four or five years ago, I was talking to one of Vanguard’s multi-billion dollar clients. They wanted to share in the great returns they had heard about alts, and they asked how they could find the best ones. My response: Look for the ones that are closed.

George U. “Gus” Sauter is a senior consultant to Vanguard Group Inc. From 2003 through 2012, Mr. Sauter served as Vanguard’s chief investment officer.